Mid-cap stocks – those with market capitalization between $2 billion to $10 billion – are less known than large and small cap stocks, but they can provide profitable investments, according to investment experts.
Quality, stability and value are typically associated with large cap stocks. Growth is usually associated with small-cap stocks. Mid-cap stocks tend to be ignored, despite the fact that such stocks have been among the best-performing equity groups since the beginning of the 21st Century, to Todd Shriber, ETF editor at Benzinga, writing in Investopedia.
Mid-cap companies are also more diversified than their small-cap peers, allowing many mid-sized companies to generate more consistent revenue and cash flow and provide more stable stock prices, according to Tom Lydon, writing in ETF Trends. Additionally, the mid-caps are not so big that their size would slow down growth.
The mid-caps segment outperformed large-caps, but with less volatility than small caps, Lydon added. The returns of mid-caps have also beaten those of small-caps during the trailing three-, five-, and 10-year periods, with less volatility.
In addition, mid-cap stocks spare investors the burden of picking stocks while providing the advantages of dividends.
What Makes A Mid-Cap Stock?
While market capitalization is based on market price, a stock priced over $10 is not necessarily a mid-cap stock, according to Investopedia. Analysts multiply the current market price by the current number of outstanding shares to calculate market capitalization.
If company A has 10 billion outstanding shares at $1, its market capitalization is $10 billion. If company B has 1 billion outstanding shares at a $5 price, its market capitalization is $5 billion. While company A has a lower stock price, its market capitalization is higher. Company B may have a higher stock price, but it has a tenth of the outstanding shares.
What Mid-Caps Offer Investors
Most financial advisors suggest a mix of low-, mid- and large-cap stocks to have a diversified portfolio, but some investors believe mid-cap stocks diversify the risk in addition to diversifying the portfolio.
Small-cap stocks, which offer the most growth, have the most risk. Large-cap stocks, which are the most stable, offer lower growth. Mid-cap stocks offer a hybrid of small-cap and large-cap stocks, a balance of stability and growth.
What To Look For
The most important thing to consider when searching for mid-cap stocks is potential for growth, according to Wall Street Survivor. Investors should seek companies that can grow faster than their larger peers in the industry, thereby gaining market share.
The company should be a largely undiscovered stock, giving it a cheaper valuation. Mid-caps that have low leverage and higher growth profiles that the market has not realized are good choices.
Investors in mid-cap ETFs must be sure the ETF they choose is not a misrepresented large-cap fund, Shriber noted.
A Model Mid-Cap Stock
Shriber observed the dividend yield for the underlying index for WisdomTree MidCap Dividend Fund (DON) is just under 3%, which surpasses the S&P 500 or 10-year Treasuries corresponding yields.
DON also compares favorably against S&P MidCap 400 Index, Shriber noted, which yields just below 1.3%. In addition, the weighted average market value of its holdings is around $5.2 billion, $16 billion under DON member firms’ weighted average market value.
DON delivers risk-adjusted returns, which is what matters, Shriber noted. Over the past three years, DON is 43.7% higher, versus the S&P MidCAP 400’s 35% gain. In addition, DON has been roughly 10% less volatile compared to the S&P MidCap 400.
Since March 2009, when the current bull market began, DON rose more than five-fold, surpassing the S&P MidCap 400.
Up 3.4% in 2017 and posting record highs, DON distinguishes itself in that more than 400 of its holdings are weighted to reflect the proportionate share of aggregate cash dividends that each component company is expected to deliver in the coming year. This projection is based on the most recently declared dividend per share.
DON’s weighted average market value holdings at the end of the first quarter were $7.1 billion, which is less than half of the Vanguard Mid-Cap Growth ETF’s weighted average market value. DON’s weighted average market value was roughly $1.8 billion over the S&P MidCap 400 Index.
DON’s 400 holdings are weighted by dividends, compared to mid-caps weighted by market value. Weighting by market value provides a large-cap fund in disguise as prices increase, Shriber noted.
The WisdomTree MidCap Dividend Index, DON’s underlying index, in the past six years has beaten the CRSP index by more than 35%.
WisdomTree noted that the 35% indicates the selection of the mid-cap is critical, rather than which mid-cap indexes will perform best over the next six years, which is not known at the present time.
While many indexes are named “mid-cap,” there is a significant difference in performance.
21.3% of the DON fund’s weight is allocated to consumer discretionary names. The CRSP index, by contrast, allocates less than 24% of its weight to consumer sectors.
DON allocates 29.1% to industrial and real estate names to improve its dividend yield to 3%, which is above average for mid-cap ETFs.
With $2.8 billion in net assets, DON generates income in a low-interest rate environment within mid-cap stocks, making it a category creator, according to Shriber. Dividends previously were considered a large-cap equity phenomenon.
A Compelling Multi-Factor Idea
Among mid-cap ETFs, Lydon of ETF Trends noted the John Hancock Multifactor Mid Cap ETF has a compelling multi-factor idea.
Hancock ETFs indexes use market-capitalization adjustments to increase the weights of smaller companies within the eligible universe and lessen the weights of larger names. The methodology indicates that the ETFs have a more equal-weight tilt with more exposure to smaller companies than traditional market-cap weighted index funds.
The Hancock ETF allocates 34% of its combined weight to industrial and technology stocks while the consumer and financial services discretionary sectors combine for 29% of the ETF’s weight. None of the 678 holdings command weights of more than 0.55%.
Hancock was among a small number of ETFs to hit record highs last week, bringing its year-to-date gain to just over 7%. The ETF debuted in September 2015 and now has more than $170 million in assets.
Investors currently have an opportunity to take advantage of the mid-cap ETFs before the benefits become more widely known.